Share buyback is a popular method for companies to add value of the shareholders.
Why is Buyback Done?
The main reason for buyback is Undervaluation of share price which leads the company to buyback of shares. The process enables repurchase of shares from the existing shareholders usually at a higher price than the market price.
Impact on Shares and Price
A buyback reduces the shares outstanding on the market while increasing the earning per share (EPS) and decreasing book value per share.
[Defining EPS: EPS is the portion of a company’s profit allocated to each outstanding share. It is an important variable in determining the share price.]
Other Important Reasons for Buyback
- Apart from this, buyback prevents mergers, takeovers and monopolization by aiding the survival of consumer sovereignty. Thus, if any other company is planning to buy the majority shares in the market, the company can fend-off such an intruder by doing a buyback and owning the shares once again.
- It rationalizes the capital structure by writing off capital not represented by available assets and are considered more tax efficient compared to dividends.
- Buybacks boost shareholder value, share price while creating tax benefit for investors with earning good returns on the gaps in prices on the basis of the company’s fundamental.
- Buybacks are done with the intention to reward company’s investors, improve financial ratios (price to earnings, return on assets and return on equity), increase promoters holding, reduce public float and check the declining stock price, reduce volatility and build investors’ confidence
How Can the Purchase Be Done?
Purchase of shares can be made out of various sources that are-
Free reserve: Reserve that is free for distribution as dividend, includes credit balance of general reserve, realised capital profit (arises from the sale of investment or fixed assets).
Securities Premium Account: It includes premium received on issue of shares, debentures and bonds, after adjusting expenses related to issue of shares.
Proceeds of Any Shares or other Specified Securities: A company cannot use proceeds of issue of equity shares to buy back equity shares, instead can use proceeds of issue of debentures or preference shares to buy equity shares.
Pricing of Buyback
Methods for buyback entails:
- Fixed price tender offer – Shareholders have the option to sell or hold the fixed number of shares, offered by the company at a fixed price. This process ensures all shareholders are treated equally, no matter they hold majority or minority stake. Recently, Indian Oil Corporation Limited has offer for buyback of 29,76,51,006 fully paid-up equity shares at a price of Rs 149 per share.
- Buying from open market – The company’s broker buyback its own shares from the market, repurchase program happen for a extended period of time as a large block of shares needs to be bought. Recently, Selean Exploration Technology Limited has offer for buyback of 16,400,000 fully paid-up equity shares at a price of Rs 300 per share.
Buy back from open market can happen through:
- Book-building process
- Stock Exchange
- Repurchase by direct negotiation – The company may buy shares from shareholder who possesses a large number of shares and wants to sell it at a negotiated price. While to calculate share of individual holder formula is:
The acceptance of shares by individual shareholders:
- Dutch auction tender offer: In this process price of offering is set after taking in all the bids to determine the higher price that can enable the sale of offering.
Most preferred methods are open market and tender process, the difference in tender process is that the price of buyback is fixed, carrying certainty on price and quality parameters while in open market process benefit to shareholder can’t be judged since company could have bought shares at a lower price.
Record of Buyback
In 2017-18, 60 companies announced buyback offers with amount of Rs 50,793 crore, the highest ever in the history of Indian capital market.
|Year||Amount (Rs Crore)||No. of issues|
Source: SEBI annual report.
How Does Buyback Impact Investors?
Investors might face confusion on the part of earnings, facing the option of buyback, which was preferred over dividends due to its financial implications and tax benefits.
However, the introduction of Long Term Capital Gains Tax has reduced the attraction, but the preference of dividend also reduced as Union Budget, 2016 highlighted “dividend receipts above Rs 10 lakh taxable at 10 percent”, imposing an additional tax on dividends for high net worth investors, making dividend payment unattractive.
Earlier companies like TCS, Infosys, HCL Technologies and L&T had completed buyback offers through tender route method.
Advantages and Repercussions of Buyback
Buyback apart from increasing earnings per share of the company also helps boost investor’s confidence in the particular company’s share.
However, past performance as a result of buyback indicate stock can move in either of the direction, though it helps the stock in most cases, still in case of decline, the apparent reason is a mismatch between buyback price and investor’s expectation.
The fluctuation in price depends on various parameters such as the market sentiments, the mode of offer (tender or open market), the size of offer, the difference between offer price and market price of the stock.
Investors are advised not to buy shares just because the company is working on buyback, instead study the company fundamentals examining its past performance and future objectives and take a decision based on its ability to generate profits. If buyback size is small as compared with the overall market capitalization of the company, lesser change can be observed in the stock. Therefore, investors should once check all the parameters of buyback offered by the company as well as the intention behind the buyback process.